JPMorgan Deserves $52 Share Price, Goldman $157

The Federal Reserve last week published its much-awaited report detailing its consent and dissent to capital plans proposed by the country’s biggest banks. While most of the banks got the mandatory clearance they sought to return more cash to investors through dividend hikes and share repurchases, Ally Financial and BB&T Corp. were not so lucky as the Fed rejected their capital plans for the year.

Quite notably, JPMorgan Chase and Goldman Sachs received only a conditional no-objection to their plans with the Fed directing them to submit new capital plans by September “to address weaknesses in their capital planning processes.” These banks have respective Trefis price estimates of $52 and $157.

The banking sector has traditionally attracted investors looking for dividends. However, in the aftermath of the global economic downturn of 2008, the banks had to cut their dividends to shore up capital – which makes sense considering the number of banks that went under during that period. Along the way, the deteriorating debt situation in Europe forced a further delay in capital plans. It was only after the stress test last year that the banking giants could finally begin paying back shareholders for their patience.

So why does the Fed have to approve the banks’ dividend plans? After all, there is no such regulatory body for other industry sectors to determine how much dividend a company is allowed to pay. To answer this question, we must first remember that one of the biggest components of any company’s capital plans for a period is the amount of cash the company intends to return to its investors over that duration.

The company can increase payout to investors through either a dividend hike or through repurchase of its stock. This is no different for a bank. But since the economic downturn and the subsequent bailout of the banks, the Federal Reserve has primarily been interested in ensuring that the banks have enough capital reserves to be able to survive another economic downturn. And in its quest to build the banks’ capital strength, the Fed ended up shouldering the responsibility of making sure that the banks do not return too much of their cash.

The Fed summarized its stand on the proposed capital plans of the country’s 18 biggest bank holding companies as shown in the table below:

Non-objection

Conditional non-objection

Objection

American Express

Goldman Sachs

Ally Financial

Bank of America

JPMorgan Chase

BB&T

BNY Mellon

Capital One

Citigroup

Fifth Third Bancorp

Keycorp

MetLife

Morgan Stanley

PNC

Regions Financial

State Street

SunTrust

U.S. Bancorp

Wells Fargo

The Fed’s rejection of Ally’s plans are no surprise – the financial institution failed the stress test as announced last week and is in a rather precarious situation capital-wise given its liabilities to the bankrupt Residential Capital. BB&T figures on the same list because of its announcement earlier this month that it has to rework incorrectly calculated risk-weighed assets figure.

As for JPMorgan and Goldman, the conditional approval should serve as a course correction for their capital return plans as the Fed believes there are underlying weaknesses to their capital structure that need to be addressed first before the banks start handing out more cash to investors. As the Fed can reject a capital plan even on qualitative grounds, the ‘London whale’ trading loss for JPMorgan would no doubt have had a role to play in the Fed’s decision to ask the bank for a resubmission.

This is the third article in our series on the Fed’s 2013 Stress Test, and its implications for the public at large. In subsequent articles we will detail the results of the test for individual banks.

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